What is the purpose of the Allowance for Doubtful Accounts?

Definition of Allowance for Doubtful Accounts

The Allowance for Doubtful Accounts or Allowance for Uncollectible Accounts is a general ledger contra account associated with the current asset account Accounts Receivable.

The credit balance in Allowance for Doubtful Accounts reduces the amount reported on a company's balance sheet for accounts receivable to the amount that is expected to be collected.

The balance sheet account Allowance for Doubtful account is also associated with the income statement account Bad Debt Expense or Uncollectible Account Expense.

Example of Allowance for Doubtful Accounts

Assume that a company has 500 customers purchasing on credit and they owe the company the $1,000,000 debit balance in Accounts Receivable.

Even though the company sold only to credit worthy customers, the company's experience is that a small percent of customers will not pay the full amount. After reviewing the customers' balances the company estimates that $10,000 of the $1,000,000 will not be collected.

Rather than waiting until the specific customers are known with certainty, good accounting requires the company to record the following adjusting entry:

  • A debit to Bad Debt Expense that will cause the income statement to report the estimated $10,000 loss closer to the time of the credit sales
  • A credit to Allowance for Doubtful Accounts that will cause the balance sheet to report that only $990,000 of the receivables will be collected

Using the account Allowance for Doubtful Accounts is preferred for financial reporting. However, it is generally not allowed for U.S. income tax reporting. You should always consultant with a tax professional for the income tax rules.

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